Apple Earnings: How To Tackle Saturation In The High-End Smartphone Market?

Apple (NASDAQ:AAPL) is set to announce its Q3 FY 2013 earnings after the markets close on July 23. The company has seen its shares decline by almost 30% in the past year on the back of slowing demand for the iPhone as well as gross margin concerns. Rising competition from other manufacturers such as Samsung (PINK:SSNLF) along with fears that the high-end smartphone market is nearing saturation have weighed heavily on the company’s shares, magnified by the uncertainty that has always surrounded Apple’s future product launches.

Although the management has alluded to some great new products being launched this fall and next year, it is not clear if these plans include a cheaper iPhone or a completely new product such as an iTV or an iWatch. Since it would be too optimistic to expect more detailed statements from Apple regarding its new product launches, the company’s gross margin performance during the quarter and fourth quarter guidance are likely to be the most important takeaways this earnings call.

Specifically with the iPhone driving almost 50% of the company’s value, we will be interested in seeing what the demand for the iPhone 5 has been in two quarters after launch in the face of competition from Samsung’s recently launched Galaxy S4. Smartphone upgrades have been a key driver of smartphone sales and are slowing down, according to a recent UBS report.

Last year, 68 million people in the U.S. upgraded their smartphones down by about 9% over 2011. The same seems to be taking a toll on Samsung as well whose earnings guidance for the June quarter came in below already modest analyst expectations. Considering that Q3 has traditionally been a slow quarter for Apple, iPhone sales are likely to see a sequential decline. But the y-o-y growth or decline will be key to understanding the resilience of iPhone demand in a high-end smartphone market that is nearing saturation.

iPhone ASP numbers are going to be another keenly watched metric this earnings call. With speculation rife that the innovation curve has flattened out at Apple, the ASP figures will be important to understand if consumers feel the same and are hence buying more of the older iPhones whose prices have been slashed. The March quarter saw iPhone ASPs drop about 3.5% over the same period last year, and the trend could continue this quarter as well.

The saturation being seen at the high-end of the market shows that Apple needs to tap the smartphone growth in emerging markets such as China better. Despite being only in the early stages of smartphone adoption, China has already pulled ahead of the U.S. as the world’s largest smartphone market by volume. This is an incredible statistic given that 3G penetration in China is in the mid-20s currently. Considering the huge 2G subscriber base of more than 850 million that the Chinese carriers are looking to upgrade to 3G, the potential for Apple to ride the boom is huge.

In order to do so, however, Apple needs a cheaper iPhone. Currently, Apple sells the iPhone through the smaller two of the three carriers in the country, China Unicom and China Telecom. A deal with China Mobile, which controls almost two-thirds of China’s wireless market, has been held up potentially due to subsidy concerns. Coming up with a cheaper iPhone for the emerging markets that does not compromise much on the build quality and margins, in a move similar to the iPad mini, could help lower the per phone subsidy costs and potentially help bring carriers such as China Mobile on board. Such a move would also translate well to other emerging economies that may want the iPhone, but due to the lack of carrier subsidies, find the retail price tag too high.

iPad mini key to future growth as PC declines

The iPad currently accounts for about 13% of Apple’s value. However, with tablets rapidly cannibalizing PC sales, this division could contribute a lot more to Apple in the coming years. The PC market is declining faster than many anticipated with Gartner and IDC claiming that the March quarter registered the most decline in PC sales in over a decade. A big reason for the decline has been the proliferation of mobile devices, especially tablets, and Apple has decided to play the market share game here by launching the cheaper iPad mini. This will not only help it preserve its first mover’s advantage, but also get more users to adopt its iOS platform which can fuel the growth of its future products. The iPad mini was therefore attractively priced, and Apple said during the last earnings call that early usage stats showed an overwhelming majority of iPad mini purchasers being first-time iPad customers.

However, Microsoft’s entry into tablets with Windows 8 is a very potent threat to Apple’s continued dominance in the tablet category. The Windows maker not only has a widely installed PC base in place, but also a mobile partnership with Nokia and other handset makers, which it can use to push for an integrated experience across all devices, mobile or PCs, in order to create a viable third ecosystem. That Microsoft’s two-pronged attack with the Windows Phone 8 and Windows 8 could endanger Apple’s iOS ecosystem advantage, causing iPhone sales to be impacted as a result, this should give Apple more reason to worry than the low-end tablet threat from Amazon and Google.

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